Commonwealth Bank of Australia thinks it could lose $3 billion if house prices collapse

The Commonwealth Bank of Australia (ASX: CBA) reported its 2018 half year results which were quite interesting to go through, you can read a summary of these results here.

What I found particularly interesting, was the bank’s view on the housing market. As you would expect, the bank says that typical housing bubble factors are “not evident in Australia”. Some of these factors sighted by the bank include:

  • Unsustainable asset prices particularly when artificially inflated by speculative investing
  • Strong loan volume growth driven by relaxed lending standards
  • Interaction of high debt levels and high interest rates
  • Domestic economic shock which would be a trigger for a price correction

Essentially what CBA is saying is that given speculative investor loans are limited by APRA’s latest regulatory changes, then there probably will not be a significant price correction, especially as interest rates and unemployment are low.

The problem is, it’s not too difficult to imagine a scenario whereby interest rates do rise significantly (CBA is currently forecasting rates to remain constant in 2018 and a 0.5% rise in 2019).

I think investors should focus more on the bank’s stress testing and how that develops in future reports. In the bank’s current stress scenario of a 31% house price decline, 11% unemployment and a reduction in the cash rate to 0.5%, it would incur cumulative losses on its home loan book of $3 billion over 3 years.

Interestingly enough, the bank estimates that in that scenario, the RBA would drop the cash rate from the current rate of 1.5% to 0.5%. My interpretation of that is that the bank is saying while there are some systemic risks, the government and regulators would intervene to save the day should the worst happen.

Overall, with a cash ROE of 14.7% which could have been higher had it not been for the Austrac fines, I still think that CBA has a role to play in some portfolios. Investors will just need to keep following the risks and how they develop over time. It will be interesting to see what National Australia Bank Ltd. (ASX: NAB), Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) report in their next update.

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Motley Fool contributor Kevin Gandiya has no position in any of the stocks mentioned.

You can follow Kevin on Twitter @KevinGandiya.

The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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